Another day, another bank in trouble

I'm calling for much more, and better, regulation for our nation's and the world's banks.

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I have to say, the events of the last 8 or so days weren't exactly on my bingo card for March 2023…

Trouble for a bunch of bankers

Three US bank failures last Friday, followed by Credit Suisse on life support by yesterday, and news overnight that another $50 billion was being guaranteed for yet another US bank, this time First Republic.

(Now, a quick plug: this afternoon, around 4.30pm AEDT, the latest episode of our podcast, Motley Fool Money, comes out. We dedicate the whole episode to the collapse of Silicon Valley Bank, but in the context of the overall system. And not in a boring way! So, if you're keen, make sure you subscribe, now, so the episode drops straight into your feed when it's available!)

But I want to take a slightly different angle, which is to call for much more, and better, regulation for our nation's (and the world's!) banks. It is clear that the regulators – correctly – have decided that they need to backstop a potential bank run at almost any bank, given the catastrophic contagion that would follow, plunging the world into what would likely be a deep and long recession.

I have sympathy for the 'moral hazard' argument, but we're looking for 'least worst' outcomes here, societally-speaking, and that means ensuring confidence in the financial system.

Which means?

Which means if you're essentially going to make the government (and the taxpayer) the last line of defence for almost every bank, you're morally obliged to make sure that defence is very, very rarely needed.

You don't have to be Einstein to know that if there were 5 banks – this week alone! – needing support, the regulations aren't working.

Here's a quick list of what I'd change:

– Back in 1933 the 'Glass Steagall' act in the US separated 'commercial' banking (the borrowing and lending stuff) from 'investment' banking. It was repealed in 1999. It should be re-enacted. And the same distinction should be enacted/retained in all other countries.

– If banks are 'systemically too big to fail' – and they are – their activities should be both curtailed and overseen more significantly. These should be ultra-low-risk entities, whose balance sheets should reflect that fact, and whose regulators should ensure that basic risk management processes are in place and functioning properly. And yes, it'd mean lower returns for shareholders. But that's better than being wiped out… just as SVB shareholders.

– We learned during the GFC that banks were taking silly positions with 'derivatives' – essentially making complex financial bets that, as we know, went very, very badly. Banks' derivatives contracts should be limited to managing the inherent risks of commercial banking – ensuring their lending and borrowing is matched off. If you want to do more than that, give up your banking licence and become a hedge fund.

– And the last one is one that I don't want to be true. But I can't escape it. It's time to break up the largest banks. Globally, but here in Australia, too. Competition itself would be improved, but that's not why (in this case) I think it should happen. We know that no bank can be truly ring-fenced in an inherently interconnected financial world. But the exposure of – and cost of fixing – a bank failure would be meaningfully reduced if the entities themselves were smaller. They'd also be infinitely easier to manage and oversee.

The vested interests will hate every single one of those ideas. Which is a sign that I'm on the right track.

The idealists will hate it because they don't think that's how the world should work. But it does.

We live in a world of picking 'least worst' outcomes, in terms of the impact on the economy and our society. I think my suggestions go part of the way to delivering that.

A tough call for the RBA

What does the RBA do now? Until this week, it had to balance inflation and economic growth on either end of the seesaw. But this week has changed the game. Increasing rates to bring down inflation has also worsened the pressure on potential bank collapses. So now the international calculus is 'inflation versus bank collapses'.

How hard can the world's central banks afford to go to curb inflation, when they risk damaging (freezing up?) the financial system?

And on the other hand, unemployment fell again this week, suggesting the economy is still very strong.

They find themselves in a very tough spot.

Everyone has a view, but the consequences of getting this wrong will be significant.

The other C word

The word of the week, this week, has been Confidence. It's essential for the functioning of the financial system, and it's what regulators have been working overtime to retain and restore.

But I hope all this news has also prompted many people to think about another C-word: Concentration.

How many Australians have 20%, 40% or 60% of their portfolios in the Big 4 banks?

Add in the regionals, and how exposed are some investors to the financial sector, writ-large?

To be clear, I am not expecting any trouble for Australian banks. But then, who expected trouble for US banks at the beginning of last week.

But even without that example, it makes no sense to be over-exposed to any individual sector of the economy, or to have your portfolio so correlated to one specific set of risks.

It is taking an unnecessary risk with your own portfolio.

Maybe use this weekend to ask yourself how diversified your portfolio truly is. And maybe plan to make some changes if the answers are uncomfortable.

Quick takes

Overblown: Growth? Value? The idea that these are discrete categories is silly. And each relies on the other. And then there's one more factor: price. People usually talk about 'themes' to dumb down the market… or because they're trying to sell something.

Underappreciated: The long term. I'm regularly asked 'What should investors do now?'. It suggests that we should do something different today, compared to last week or last month. My answer is usually a version of: The same thing investors should always do: buy shares of a business when the price undervalues the company's long term potential.

Fascinating: The next version of 'ChatGPT' – the artificial intelligence program that's taking the world by storm – was released this week. It apparently made a whole website based on a drawing, and passed, with flying colours, a whole stack of standardised tests. The pace of improvement is astronomical, and it's going to continue.

Where I've been looking: There's a lot of pressure on bank share prices at the moment. Which, as a sometime-contrarian, means I've been looking. ANZ Group Holdings Ltd (ASX: ANZ), with a P/E under 10, could be a bargain, particularly if margins continue to increase. Or not, if they don't, and mortgage defaults rise meaningfully. But it's a tempting idea.

Quote: "People calculate too much and think too little." – Charlie Munger

Fool on!

SVB Financial provides credit and banking services to The Motley Fool. Motley Fool contributor Scott Phillips has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has positions in and has recommended SVB Financial. The Motley Fool Australia has recommended SVB Financial. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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